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THE DAY AHEAD: Ariba pays up for sales-impaired startup

What's a business-to-business startup to do when it has about $267,000 in sales since inception and doesn't stand much of a chance on the IPO market? Find a well-heeled acquirer such as Ariba to fork over $581 million and sell out.

Ariba (Nasdaq: ARBA) said after the closing bell Monday it would acquire privately held SupplierMarket.com for roughly 6.6 million of its common stock. SupplierMarket.com was planning to offer 10 million shares priced between $9 and $11. At $10 a share, SupplierMarket.com would have had a market capitalization of $412 million based on its post IPO shares outstanding.

Ariba was sure to point out that the shares that would be issued were less than 3 percent of its shares outstanding.

There's a good reason Ariba toned down the dilution impact of SupplierMarket.com. The Burlington, MA startup has been registered for an initial public offering since March. That means it's relatively easy to find out what Ariba acquired. Shareholders often don't get a lot of details when companies such as Ariba buy privately held firms.

When you look under the hood of SupplierMarket.com you get two realities. First, there's the acquiring company's spin. In this case, Ariba touted SupplierMarket.com's technology that links buyers and sellers and allows them to find new trading partners. Ariba also played up the fact that SupplierMarket.com has 7,700 registered buyers and more than 12,000 registered suppliers.

Sounds great right? And then you read SupplierMarket.com's regulatory filings. The company runs a direct materials marketplace. Direct materials range from bolts, nuts and fasteners to rubber and glass products to corrugated packaging to injection and blow-molded plastic components. The technology may be great and SupplierMarket.com may have plenty of registered users, but sales are light.

Since Feb. 12, 1999 (inception) to Dec. 31, 1999, SupplierMarket reported sales of $51,541. The good news is SupplierMarket.com's sales ballooned to all of $216,791 for the three months ending March 31. The company lost about $19.9 million since inception.

Simply put, Ariba issued $2,680 in stock for every dollar of sales brought in by SupplierMarket.com. In addition, SupplierMarket.com relied on one customer for 91 percent of its March quarter sales. That customer, Simmons, a leading mattress maker, also had ties to SupplierMarket.com's private shareholders. In its filings, SupplierMarket.com said it expected more customers in the June quarter, but it was unlikely the company would have seen sales of $1 million or more.

We recently spoke to a SupplierMarket.com official at a B2B conference and he acknowledged the company could have to wait awhile for an IPO. Part of SupplierMarket.com's wait was related to a volatile IPO market. The other factor was most likely the weak sales. Investors have become increasingly picky about what IPOs they back.

The company had inked sales pacts with Parametric Technology (Nasdaq: PMTC) and Agile Software (Nasdaq: AGIL), but the company was green to say the least. An acquisition by Ariba was a great exit strategy for SupplierMarket.com.

Why? It wasn't clear that SupplierMarket.com would have been able to compete on its own. The company cited Ariba, FreeMarkets (Nasdaq: FMKT), VerticalNet (Nasdaq: VERT) and Commerce One (Nasdaq: CMRC) all as potential competitors. Meanwhile, SupplierMarket.com sold out for about the same market cap as niche B2B players Onvia.com (Nasdaq: ONVI), eMerge Interactive (Nasdaq: EMRG) and Neoforma (Nasdaq: NEOF).

Ariba's pitch is that it can take SupplierMarket.com and combine it with its network. When this alleged "network effect" takes off, SupplierMarket.com will ramp up sales dramatically. If you're an Ariba shareholder, you have to wonder if Ariba paid too much. One thing is guaranteed: SupplierMarket.com execs are smiling this morning.